XM Is Out of This World

It's a bird, it's a plane, it's a stock that has quintupled in the past two years! The stock is XM Satellite Radio (Nasdaq: XMSR) , and XM the company recently made news when it announced that it had signed up 540,000 subscribers from January through March of this year.

Hugh Panero is the CEO of XM. The Motley Fool recently had an opportunity to talk with him about the out-of-this-world business of satellite radio. In the first installment of our three-part series, we talk current subscribers, future growth, and potential profitability.

TMF: Hugh, 540,000 new subscribers in this first quarter of 2005. How many total subscribers do you now have, and how many do you anticipate by the end of this year?

Hugh Panero: We currently have about 3.8 million subscribers, and we have projected to end the year with over 5.5 million.

TMF: How about for the fun of it, 2010, five years from now, ballpark?

HP: Well, we think this is an enormous business, and we think that XM could have well over 20 million subscribers by 2010. It is based on the attractiveness of our product, with its commercial-free music channels and its array of different talk entertainment and sports programming.

TMF: Let me ask you: In April, your service went from being priced at $9.99 a month to $12.95 a month. Do you see a significant drop-off in new subscribers this quarter as a result of the price hike?

HP: We see no drop-off. The way we instituted our price increase was to provide the existing subscribers an opportunity to lock in at the lower rate by signing up for a variety of different plans. We did that because those are the subscribers who got us here. So it has had very little impact. In fact, our phones are lit up with people signing up for the long-term discounted rate.

TMF: Of course, stock market observers love it when companies can demonstrate successful price raises. For those unfamiliar, can you walk us through XM and how you make money, Hugh?

HP: We make our money basically on subscription revenues, which come from the $12.95 that you just mentioned, and ad revenue, which is basically focused on our non-music programming. We have a business where the infrastructure is built, and therefore, once you get through a certain period of development or growth, you have fairly high returns because you are not like a cable company or cellular company, where you are having to add more capital every single year to build out some different territory in order to reach consumers. Because of our satellite platform, we reach the entire United States.

TMF: Let's look three to five years ahead. What do you see as being the mix between subscription revenues and advertising revenues, let's say five years from today?

HP: Well, I think the subscription revenues, which dominate the revenue pie right now -- obviously on the very high side of 90% -- are coming from subscription revenues, but I think that as we have broken through a number of subscriber milestones, as one million, two million, three million, and in several months we will basically break four million and we will end the year with over five, you really start to have an audience size that becomes very appealing to advertisers, especially when we can offer them opportunities to reach very upscale consumers, broken down by very definitive market segments because of the kinds of unique content that we offer.

TMF: Hugh Panero, we last had you on this show in November of 2003, and we asked you when you thought XM Satellite Radio would break even. At the time, you thought by the end of 2004. That hasn't happened yet. How come?

HP: Well, we actually made some changes to the model. We made some fairly significant investments in content, technology, and infrastructure, and we made decisions on how we wanted to evolve the business. We also grew faster, and there is a cost to growing it sometimes. We basically now have projected that we are going to hit cash-flow breakeven in 2006. We are still, and if you look at the metrics of the company and some of the key expense areas that contribute to getting to breakeven, such as our subscriber acquisition costs or our cost per gross ads, what The Street has given us a lot of credit for is that we have driven those costs down. They are significantly lower than they were a year ago or two years ago.

TMF: You say there are a few metrics to pay attention to, and I get that. A lot of investors would probably like to know what you think are the two, three, maybe even four most important numbers to be following?

HP: Well, I think the numbers that I mentioned before are the ones that people focus on -- the subscriber acquisition cost, which is a subcomponent of an even more important metric, the cost per gross add. That is, basically, what is the cost to get that next subscriber? Those are the ones that we actually break out for The Street and show to them in detail. That is the big issue.

Obviously, the other thing that we watch fairly carefully is some of our fixed costs, particularly in the programming area. We make programming decisions in a very prudent way. Major League Baseball was a terrific deal for us. It was an expensive deal, but we thought it was the right deal. You can't make every single investment in every piece of programming out there, because my experience from the cable industry and the pay-per-view industry and other content platforms I have been on is that those kinds of expenses can eventually bury you. We try to make them in a very reasonable way and with the idea that those investments are not just to create a splash because they get a headline someplace but because they are actually going to add subscribers, which adds to revenue and adds to us getting to the cash flow breakeven in certain time frames.

Come by tomorrow for part two of our conversation with XM Satellite Radio CEO Hugh Panero!

Fool co-founder David Gardner heads up theMotley Fool Rule Breakersnewsletter service, which seeks out companies like XM that are breaking the rules in their industries. Want to see what stocks David thinks are worthy of Rule Breaker status? He's offering a free, 30-day trial -- take a look!

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